Real estate asset protection versus high stakes

13 April 2017   Category: News, Asia, Global, Hong Kong, Japan, Singapore   By David Macfarlane

Global investors’ and fund managers’ appetites for real estate investment remain strong with over 50 billion euros (US$53.14 billion) of institutional capital expected to flow into the niche market this year, according to a survey released in January by European Association for Investors in Non-Listed Real Estate Vehicles, Asian Association for Investors in Non-Listed Real Estate Vehicles, and Pension Real Estate Association.

However, when it comes to real estate asset protection versus high stakes: is chasing high yields still realistic in today’s market?

Strong capital flows to Asia Pacific real estate in recent years have largely contributed to the ongoing yield compression trend across the region, which spurred some investors to opt for riskier higher-yielding assets in secondary locations. Much of the capital growth was front loaded and realised till 2016, leading to diminished prospects of capital growth over coming years. Therefore, returns in coming years are likely to be driven mostly by income yields.

According to Koichiro Obu, head of research & strategy, Asia Pacific, at Deutsche Asset Management, while monetary policies in Asia Pacific are likely to remain broadly in support of economic growth, a rising yield environment in developed Western countries poses risks of increasing cap rates over a multi-year horizon, particularly for trade-dependent economies such as Singapore and Hong Kong where domestic yields are highly correlated to global yields.

“Hence investors need to adopt a selective approach in their investments, evaluate specific supply-demand factors, and consider whether future rental growth is sufficient to offset any potential yield decompression,” he says in an interview with Asia Asset Management (AAM).

Mr. Obu continues: “Nonetheless, pockets of opportunities remain available. For instance the logistics sector generally tends to provide higher asset yields with longer-term cashflow stability, while regional cities in Japan are expected to provide favourable excess returns over local government bonds for investors with access to local financing as borrowing costs are likely to remain low over the next few years.

Historically, some classic mistakes investors have made include chasing high yields by taking on uncompensated risks, points out Elysia Tse, head of research & strategy, Asia Pacific, at LaSalle Investment Management, who claims a steady increase of the “defensiveness” of their real estate portfolios should be considered during the late stage of a market cycle.

“Investors should also recognise that the elevated liquidity in recent years has pushed real estate prices to historically or cyclically high levels. In light of the recent market capital development, it is prudent for fresh capital to adopt a lower return expectation for similar risk profile investments,” Ms. Tse remarks in an interview with AAM. As a result, she says investors seeking higher returns should consider focussing on cash-on-cash yields and the maximisation of net income capacity for “build-to-core” or “value add-to-core” strategies in markets with recovering fundamentals where exit timing can be appropriately managed.

Relatively higher yield in the current market is still feasible with real estate investment in underinvested submarkets, subsectors and lower gradation buildings, adds Jonathan Hsu, Asia head of research at M&G Real Estate, who goes on to explain that in order to mitigate the risk of asset price devaluation, prudent submarket and asset selection is required. “The alternative is to move higher on the risk spectrum and take on additional leasing and development risks,” he tells AAM.